What is negative equity? Meaning, how it impacts your house and mortgage explained amid falling house prices

So far, autumn 2022 has been a traumatic season for people who are in, or trying to get into, the housing market.

House prices have been falling from record highs since the summer as a result of slowing activity caused, in part, by the UK cost of living crisis. Consumers have been forced to rein in spending as a result of record inflation squeezing their household budgets.

Meanwhile, those seeking to get a mortgage have faced steep interest rate hikes as a result of an increase in the Bank of England base rate and the fallout from Liz Truss’s mini budget.

While rates are believed to have peaked, a lengthy recession has been predicted which could see unemployment levels double over the next two years. Should this situation arise, not only could household incomes fall, but the housing market could slow further as a result of fewer new homes coming to the market.

So, with falling house prices and a further slowdown in activity on the cards, should you be worried about negative equity? Here’s what you need to know.

What is negative equity?

Negative equity is defined by the government’s Money Helper service as being when a house or flat is worth less than the mortgage taken out on it. Essentially, it is a form of debt.

Say you’ve purchased a property for £250,000 - £225,000 of which is mortgage - and it is now worth £210,000, you would be in negative equity. Lenders might say your loan-to-value (LTV) rate has gone above 100%.

However, you might not realise this has happened. You can only find out for sure if you check how much you owe your mortgage lender and get a valuation from an estate agency or a surveyor. If the valuation they come back with is below what you owe, you’re in negative equity.

For much of the past decade, it has been a relatively uncommon phenomenon as house prices have been rising at a more rapid rate than general inflation. But, with house prices now falling back from record highs and fears house price growth could soon turn into decline, negative equity is likely to become much more common.

What does negative equity mean for you?

Negative equity is not a disaster, so long as the difference between the property’s value and your mortgage is small and you’re not planning to move anytime soon.

It only becomes a big issue if you’re aiming to sell your house or flat, or if you’re looking to remortgage. Should you be seeking to sell, it’s likely you’ll need to have enough savings to pay off the difference between your home’s valuation and the amount you owe in mortgage.

Mortgages that allow you to take your negative equity with you do exist, but are only offered by a handful of lenders. They often come with high interest rates and you may find you have to pay out extra money to pay off fees and charges.

If you really need to move, you could also sell your home and move into rented accommodation - but, unless you sell your home above its valuation and bring the LTV down below 100%, you will still need to pay off the debt you have with your mortgage lender.

When it comes to remortgaging, you may be forced to take a standard variable rate (SVR) mortgage instead of being able to access cheaper fixes. This type of mortgage tends to be more expensive than the rate you would get with a deal.

Given we’re in a cost of living crisis, interest rates are the highest they’ve been for more than a decade, and people are more likely to become unemployed during the looming recession, having to move onto an SVR rate could push repayments beyond what you could afford.

If this happens to you, speak to your lender in the first instance. They may be able to work with you to help you get out of your predicament.

How can I get out of negative equity?

Fortunately, there are ways to escape the clutches of negative equity. While they are not necessarily easy ways out, the following things could prove to be extremely helpful down the line, according to comparison site MoneySupermarket:

• Wait it out

Time can be your best friend, particularly if you have a long-term mortgage fix. If you wait it out over the medium-to-long term, the chances are that house prices will rise enough that you will be carried out of negative equity.

While experts are not unanimously predicting a housing market crash, it is likely prices will fall back over the next year - although, crucially, they could well remain in overall growth. Over the longer-term, with inflation expected to reduce sharply from mid-2023 and interest rates likely to slowly reduce by 2025, prices and mortgage repayments could well be in a better place if you’re able to hold out for a few years.

It’s also worth noting that as your home’s value rises you will own more of it outright, which will lower your LTV and make it harder to fall back into negative equity.

• Overpay your mortgage

If you repay more than you need to each month, you can reduce the amount you owe on your mortgage. But, you should make sure your overpayments do not exceed those allowed under your mortgage terms.

Many mortgages restrict how much you can overpay. If you do go over the overpayments limit, you could find yourself paying an extra charge.

• Make home improvements

You can boost the value of your home by renovating it. Extensions, loft conversions and refits can all significantly improve your property’s price when it comes to selling it.

But, the issue is that these investments can be risky. If you need to take a loan out to do them, you may find yourself in even more debt than you started out with.

Also, with current supply chain issues and rapid inflation, the cost of materials and getting the work done is likely to be high. So, if you have spare cash, it could be worth using it to pay off the difference to get your LTV below that crucial 100% mark.